UNIVERSITY 

OF  CALIFORNIA 

LOS  ANGELES 


SCHOOL  OF  LAW 
LIBRARY 


Income  Taxes 


Modern  American  Law  Lecture 


Blackstone  Institute,  Chicago 


INCOME  TAXES 


BY 

Hon.  THOMAS  E.  LYONS,  A.B.,  LL.B. 

MEMBER  WISCONSIN  TAX  COMMISSION 


One  of  a  Series  of  Lectures  Especially  Prepared 
for  the  Blackstone  Institute 


BLACKSTONE    INSTITUTE 
CHICAGO 

Copyright,    1920,    by    Blackstone    Institute 


T 


THOMAS  E.  LYONS 


THOMAS  E.  LYONS 

The  author  of  this  article  was  born  and  raised  on  a 
farm  in  Wisconsin  and  has  always  resided  in  that 
stale.  After  the  usual  training  in  the  district  and 
high  school  he  entered  the  University  of  Wisconsin 
in  1882,  graduating  from  the  College  of  Letters  in 
1885.  For  the  next  four  years  Mr.  Lyons  served  as 
county  superintendent  of  his  native  county  and  then 
returned  to  the  Law  School,  from  which  he  received 
the  degree  of  LL.B.  in  1890.  For  the  next  twenty 
years  he  was  engaged  in  the  general  practice  of 
law  at  Superior,  Wisconsin,  during  which  time  he 
served  successively  as  school  commissioner,  library 
director  and  city  attorney.  In  1911  he  was  appointed 
a  member  of  the  Wisconsin  Tax  Commission  and  still 
holds  a  position  on  that  board.  He  has  written  several 
articles  on  various  phases  of  taxation. 

The  Wisconsin  Tax  Commission  has  supervision 
over  the  assessment  of  the  general  property  of  the 
state  and  exclusive  jurisdiction  over  the  assessment 
of  public  service  companies  and  administration  of  the 
income  tax.  Wisconsin  was  the  first  to  demonstrate 
that  a  state  income  tax  law  can  be  successfully  ad- 
ministered. Mr.  Lyons'  legal  training  and  intimate 
acquaintance  with  the  subject  of  taxation  in  general 
and  particularly  with  the  practical  operation  of  fed- 
eral and  state  income  taxes  is  a  sufficient  guarantee 
that  the  reader  will  find  the  following  pages  both 
interesting  and  authoritative. 


INCOME  TAXES 


THOMAS  E.  LYONS,  A.B.,  LL.B. 

INTRODUCTION 

Taxation  under  legislative  control  is  a  compara* 
tively  modern  development.  In  the  early  stages  of 
society  there  were  no  taxes  and  the  gifts  later  paid 
to  tribal  chiefs  were  of  a  personal  rather  than  of  a 
public  nature.  Even  the  services  rendered  to  the  lord 
paramount  or  to  the  king  in  feudal  times  were  in 
the  nature  of  compensation  for  protection  furnished 
or  for  the  use  of  a  freehold  and  not  taxes  in  the 
proper  sense.  The  nearest  approach  to  taxes  under 
the  feudal  order  was  the  payment  made  in  money 
as  commutation  for  feudal  services.  In  time  these 
exactions  came  to  be  looked  upon  as  taxes  and 
became  the  subject  of  great  abuse.  One  of  the 
important  guaranties  of  Magna  Charta  is  that  "No 
scutage  or  aid  shall  be  imposed  on  our  realm  save  by 
the  common  council  of  our  realm."  King  John  was 
stripped  of  all  his  power  to  impose  these  burdens 
except  as  to  the  three  customary  feudal  aids  of  con- 
tribution in  the  case  of  the  king's  captivity,  on  the 
knighthood  of  his  eldest  son  and  on  the  marriage  of 
his  eldest  daughter.  The  Declaration  of  Rights  in 
1689  provided  that  the  "  levying  of  money  for  or  to 
the  use  of  the  crown  by  pretense  of  prerogative  with- 

5 


6  MODERN  AMERICAN  LAW  LECTURE 

out  grant  of  parliament  for  longer  time  or  in  other 
manner  than  the  same  is  or  shall  be  granted  is 
illegal."  We  have  here  the  beginning  of  legislative 
control  over  taxation  and  this  provision  the  his- 
torian Green  declared  "to  be  the  greatest  constitu- 
tional change  which  our  history  has  witnessed." 
From  that  time  forward  there  has  been  a  constant 
effort  among  organized  governments  to  apportion 
public  expenditures  according  to  the  taxpayer's  abil- 
ity to  pay,  and  the  income  tax  marks  the  latest  step 
in  the  evolution  of  that  effort. 

The  first  attempt  in  this  direction  was  the  poll  or 
capitation  tax.  In  primitive  society,  when  every- 
thing was  produced  by  individual  exertion  and  pri- 
vate property  had  but  slightly  developed,  the  head 
or  poll  tax  formed  a  fairly  satisfactory  basis  of  taxa- 
tion. But  with  the  development  of  private  property 
differences  in  economic  conditions  began  to  appear 
and  the  poll  no  longer  constituted  a  proper  unit  for 
the  distribution  of  public  burdens.  As  the  defects 
in  the  poll  tax  came  to  light,  attention  was  directed 
to  product  as  the  test  of  ability  and  for  a  tune  taxes 
were  imposed  accordingly.  As  the  product  from  dif- 
ferent classes  of  property  and  from  the  same  class 
under  different  conditions  varied  from  time  to  time, 
it  became  necessary  for  the  purpose  of  stability  to 
estimate  by  outward  signs  and  often  in  advance.  The 
extent  of  land  holdings,  the  character  and  size  of 
dwellings,  stores  and  factories  and  at  one  time  the 
number  of  windows  in  houses  were  used  as  the  meas- 
ure of  the  tax.  These  capricious  tests  often  resulted 
in  hardship  and  led  to  the  selection  of  expenditure 


INCOME  TAXES  7 

as  the  basis  of  contribution  to  public  burdens.  But 
it  soon  developed  that  expenditure  failed  to  distin- 
guish between  the  spendthrift  and  the  miser  and  the 
relatively  greater  expenditure,  in  proportion  to 
ability,  of  the  poor  than  the  rich.  Of  necessity  indus- 
trial classes  spend  most  of  their  earnings  for  self- 
support  whereas  the  wealthy  can  live  handsomely  on 
a  meager  fraction  of  their  incomes.  In  due  course 
this  test  of  ability  also  fell  into  disfavor. 


The  increasing  difference  between  those  who  owned 
property  and  those  who  did  not  gradually  led  to  the 
selection  of  that  test  as  the  basis  of  taxation,  and  ulti- 
mately produced  the  general  property  tax.  This  being 
the  prevailing  system  of  taxation  during  the  forma- 
tive period  of  our  history,  it  was  adopted  by  all  the 
American  states  and  still  constitutes  the  framework 
of  their  tax  systems.  In  1912  it  was  estimated  that 
the  property  tax  produced  not  less  than  75  per  cent, 
of  all  our  public  revenue. 

Under  this  system  taxes  are  distributed  according 
to  the  value  of  property  owned  by  the  different  mem- 
bers of  the  community.  While  property  was  simple 
in  character  and  limited  in  quantity  and  the  duty  of 
the  assessor  was  to  measure,  weigh  and  count,  this 
test  proved  fairly  satisfactory.  But  as  industry  and 
commerce  developed  and  new  forms  of  personal  prop- 
erty came  into  being,  the  difficulties  of  administration 
increased  and  the  relative  equality  disappeared.  The 
property  tax  at  its  best  lacks  elasticity ;  it  falls  upon 
the  owner  in  his  losing  as  well  as  in  his  prosperous 


8  MODERN  AMERICAN  LAW  LECTURE 

years,  and  applies  with  equal  severity  to  productive 
and  unproductive  property.  These  considerations 
soon  led  to  widespread  dissatisfaction  with  the  gen- 
eral property  tax  and  it  has  been  either  abandoned 
or  greatly  subordinated  in  all  parts  of  the  world 
except  in  the  United  States. 

The  radical  defect  in  all  these  methods  of  taxation 
was  their  utter  failure  to  recognize  and  provide  for 
differences  in  social  and  economic  conditions.  The 
inequality  between  the  rich  and  poor  was  ignored 
by  the  capitation  tax,  and  the  difference  in  the  de- 
gree of  productiveness  was  ignored  by  the  prop- 
erty tax.  The  products  tax  took  no  note  of  the 
relative  expenditures  required  to  produce  the  yield, 
and  the  consumption  tax  offered  a  premium  to 
the  penurious  rich  while  it  penalized  the  improvi- 
dent poor.  Neither  of  these  systems  took  note  of 
the  varying  degrees  of  indebtedness  of  the  person 
charged  with  the  tax.  Obviously  a  more  accurate  test 
was  needed  and  was  thought  to  be  found  in  the  income 
tax.  Considered  from  this  standpoint  as  Professor 
Seligman  states,  "There  is  no  doubt  that  taking  it 
by  and  large  the  income  tax  more  accurately  responds 
to  modern  demands  than  any  of  the  preceding  tests." 

INCOME  TAX  DEFINED 

An  income  tax  is  a  direct  levy  by  a  government 
upon  the  income  of  individual  citizens  whether  that 
income  is  received  from  labor,  industry,  investment, 
real  estate  or  any  other  source,  computed  annually 
or  at  stated  intervals,  Bliss,  Encyclopedia  of  Social 
Reform,  600.  It  is  in  effect  a  tax  based  upon  and 


INCOME  TAXES 

measured  by  the  earnings  of  person  or  property,  or 
of  both  combined. 

Income  taxes  differ  from  property  taxes,  which  are 
either  imposed  upon  property  direct  and  become  a 
lien  thereon,  as  in  the  case  of  real  estate,  or  are  made 
a  charge  against  the  person  by  reason  of  ownership, 
as  in  the  case  of  personal  property,  regardless  of 
productiveness  except  as  that  element  may  be  reflected 
in  market  value.  They  differ  from  occupation  and 
other  excise  taxes,  which  are  exactions  for  engaging 
in  particular  lines  of  business  or  in  an  ordinary  line 
of  business  in  a  particular  way ;  and  they  differ  from 
consumption  taxes,  which  are  measured  by  expendi- 
ture. 

Income  taxes  are  not  levied  upon  property  nor 
upon  the  operations  of  trade  and  business,  or  the  per- 
sons employed  therein;  nor  upon  the  practice  of  a 
profession  or  the  pursuit  of  a  trade  or  calling.  They 
are  taxes  levied  upon  the  acquisitions  arising  from 
one  or  more  of  these  sources.  Ordinarily  the  tax  is 
based  upon  the  excess  of  such  acquisition  for  a  given 
period  over  a  certain  minimum  sum  called  an  exemp- 
tion. They  are,  therefore,  taxes  upon  the  periodical 
accretions  produced  by  personal  effort  or  from  the 
use  or  disposition  of  property  or  of  all  of  these  com- 
bined. 

DEVELOPMENT  OF  INCOME  TAX 

As  might  be  expected,  the  first  attempts  to  apply 
the  principle  of  income  taxation  were  crude  and  ill- 
considered,  and  the  income  tax  in  its  present  form  is 
the  growth  of  many  years.  During  the  early  middle 
ages  salaries  were  some  times  taxed,  and  as  trade  and 


10  MODERN  AMERICAN  LAW  LECTURE 

commerce  developed  a  rough  attempt  was  made  to 
measure  the  gains  of  business  and  impose  a  tax  ac- 
cordingly. But  in  all  these  cases  the  income  was 
estimated  and  largely  measured  by  the  property  pos- 
sessions of  the  taxpayer  and  his  apparent  rather  than 
his  actual  ability.  The  mediaeval  system  therefore 
was  but  a  slight  modification  of  the  property  tax, 
supplemented  by  a  charge  against  the  business  man 
and  the  laborer.  While  ability  is  continually  men- 
tioned as  a  test  during  this  period,  an  examination 
of  the  laws  will  disclose  that  property  or  product 
instead  of  income  was  generally  made  the  criterion. 

In  Italy. — As  the  Italian  cities  developed  into  cen- 
ters of  industry  and  trade  in  the  middle  ages,  a  deter- 
mined effort  was  made  to  reach  the  great  fortunes 
accumulated  by  merchants  and  traders.  Florence 
devised  a  scheme  of  taxation,  called  the  estimo,  based 
upon  the  estimated  wealth  and  ability  of  the  taxpayer. 
About  the  middle  of  the  fifteenth  century  the  estimo 
gave  way  to  the  catasto,  which  was  soon  after  made 
progressive  under  the  name  of  the  scala,  with  many 
of  the  characteristics  of  the  modern  income  tax. 
With  the  restoration  of  the  artistocratic  regime  in 
the  sixteenth  century  both  the  catasto  and  scala  were 
replaced  by  a  family  tax,  again  shifting  the  burden 
to  the  poor. 

In  France. — The  history  of  taxation  in  France  pre- 
sents many  of  the  same  characteristics.  The  tattle 
was  but  a  modified  form  of  the  English  tallage,  origi- 
nally computed  according  to  the  amount  of  land  but 
later  modified  by  considerations  of  ability  to  pay.  In 
1710  Louis  XIV  enacted  the  so-called  dixieme,  or 


INCOME  TAXES  11 

tenth,  based  on  product  and  property,  corresponding 
to  the  tithes  of  biblical  times,  and  the  tenth  and  fif- 
teenth in  England  during  the  middle  ages.  The 
dixieme  continued  in  force  until  the  revolution  but 
the  classes  to  which  it  applied  secured  so  manr  modi- 
fications and  exemptions  that  both  its  equality  and 
producing  power  were  greatly  impaired.  The  devel- 
opment of  trade  and  industry  in  the  eighteenth  cen- 
tury stimulated  the  effort  to  tax  profits  derived  there- 
from in  both  France  and  England,  but  in  neither 
case  did  the  means  employed  attain  the  characteristics 
of  the  modern  income  tax. 

In  England. — The  demands  of  the  Napoleonic  wars 
called  for  a  revision  of  the  English  fiscal  system  and 
in  1798  the  aid  and  contribution  act,  or  triple  assess- 
ment, was  passed  under  the  leadership  of  Pitt.  This 
law  was  designed  to  distribute  the  tax  burden  accord- 
ing to  the  taxpayer's  general  ability,  as  measured  by 
both  property  and  income.  While  the  tax  provoked 
most  violent  opposition,  the  increasing  yield,  from 
two  million  pounds  the  first  year  after  its  enactment 
to  nearly  sixteen  million  pounds  in  1815,  gained  it 
favor  as  an  emergency  measure  and  the  merits  of  the 
income  tax  have  been  universally  recognized  from  that 
day  forward.  But  the  triple  assessment  was  not  an 
income  tax  in  the  modern  sense  and  it  was  not  until 
1842  that  England  permanently  adopted  the  system 
of  income  taxation.  The  act  of  that  year  was  pre- 
sented by  Sir  Robert  Peel  to  compensate  for  the  loss 
of  revenue  resulting  from  repeal  of  the  corn  laws, 
with  the  express  understanding  that  it  was  to  be 
a  temporary  measure.  But  the  gradual  recognition 


12  MODERN  AMERICAN  LAW  LECTURE 

of  the  merits  of  the  system,  coupled  with  the  increas- 
ing needs  of  the  empire  for  public  revenue  prevented 
even  Gladstone,  in  his  day  of  power,  from  repealing 
it.  It  may  be  said,  therefore,  that  the  Peel  act  is  the 
parent  of  all  modern  income  taxes,  and  that  the  devel- 
opment of  the  system  as  now  known  is  the  growth 
of  the  last  half  century. 

In  Germany. — Feeble  and  sporadic  attempts  to 
tax  income  began  in  Germany  in  1820  and  were 
continued  between  1848  and  the  Franco-Prussian 
War.  It  was  not  until  1891  wfcen  the  Prussian  in- 
come tax  was  enacted  that  the  system  in  its  modern 
form  was  introduce'cl  into  that  country.  The  Prus- 
sian law  followed  the  English  income  tax  in  its  main 
features  but  provided  more  positive  and  arbitrary 
means  of  assessment  and  made  less  use  of  the  effort 
to  collect  at  source.  The  increasing  demand  for 
revenue  and  the  success  of  the  Prussian  income  tax 
led  to  its  general  adoption  in  the  other  states  of 
Germany.  In  1910  twenty-one  of  the  twenty-six 
states  of  that  country  and  many  municipalities  had 
adopted  the  system.  An  imperial  tax  was  imposed  in 
1913,  and  since  the  present  European  war  broke  out 
all  the  belligerent  countries  have  further  availed 
themselves  of  the  system. 

In  tlie  United  States. — The  taxation  of  incomes  had 
never  been  generally  adopted  in  this  country  prior 
to  1913.  In  several  of  the  colonies  the  principle  was 
utilized  prior  to  the  adoption  of  the  constitution  but 
not  in  its  modern  form.  A  federal  income  tax  act  was 
enacted  to  meet  the  demands  of  the  Civil  War  in  1862 
which  continued  in  force  until  1871.  The  law  was 


INCOME  TAXES  13 

modified  and  the  rates  increased  from  time  to  time 
resulting  in  a  yield  of  $73,434,709  in  1866  and  an 
aggregate  of  $376,290,600  during  the  entire  period 
of  its  existence.  A  general  income  tax  law  was  enacted 
by  Congress  in  1894  but  it  was  held  void  by  the 
supreme  court  because  a  direct  tax,  within  the  mean- 
ing of  the  constitution,  and  not  levied  according  to 
population  and  representation  in  Congress,  as  pro- 
vided by  Article  I  of  that  instrument,  Pollock  vs. 
Farmers  Loan  &  Trust  Co.,  157  U.  S.  429;  158  U.  S. 
601.  As  the  result  of  this  decision  steps  were  taken 
to  amend  the  constitution  so  as  to  provide  for  the 
taxation  of  incomes  relieved  of  the  restriction  that 
the  apportionment  be  made  according  to  population, 
followed  by  the  adoption  of  the  sixteenth  amendment 
by  the  requisite  number  of  states  in  1913.  In  1909 
Congress  provided  for  an  excise  tax  of  one  per  cent, 
on  the  net  income  of  corporations,  which  was  in  effect 
an  income  tax  as  to  them  and  was  later  sustained  by 
the  supreme  court  in  the  case  of  Flint  vs.  Stone 
Tracy  Co.,  220  U.  S.  107.  The  adoption  of  the  six- 
teenth amendment  expressly  authorizing  the  taxation 
of  income,  followed  by  federal  act  of  1913  and  the 
revision  of  1916,  marks  the  first  step  toward  the 
permanent  adoption  of  income  taxation  in  this 
country. 

In  the  American  States. — In  the  meantime  about 
twenty  states  had  experimented  with  an  income  tax 
in  one  form  or  another.  Several  of  the  Atlantic  and 
Southern  states  resorted  to  this  means  of  raising 
revenue  about  the  middle  of  last  century  and  the 
system  was  extensively  used  by  the  states  of  the  Con- 


14  MODERN  AMERICAN  LAW  LECTURE 

federacy  during  the  Civil  War.  But  few,  if  any,  of 
these  enactments  provided  for  the  taxation  of  all 
forms  of  income.  As  a  rule  they  were  confined  to  the 
taxation  of  income,  derived  from  sources  not  other- 
wise taxed,  such  as  salaries,  fees,  commissions  and 
profits  derived  from  the  purchase  and  sale  of  prop- 
erty. 

SPREAD  OP  THE  INCOME  TAX 

As  pointed  out  by  Professor  Seligman,  during  the 
last  quarter  of  a  century  there  has  been  a  strong  trend 
toward  the  system  of  income  taxation.  Congressman 
Hull,  in  presenting  the  1913  income  tax  bill  to  Con- 
gress, said: 

During  recent  years  there  has  been  a  general  agitation  and 
demand  in  almost  every  state  in  the  union  and  in  almost  every 
country  in  the  world  for  intelligent,  fair  and  practical  reforms 
and  readjustments  of  their  tax  systems  to  the  end  that  every 
citizen  may  be  required  to  contribute  to  the  wants  of  the  govern- 
ment in  proportion  to  the  revenue  he  enjoys  under  its  protec- 
tion. To  this  end  the  doctrine  of  equality  of  sacrifice  or  ability 
to  pay  is  being  universally  invoked. 

President  Wilson  in  his  message  to  Congress  in 
December,  1915,  declared  that  "We  should  be  follow- 
ing an  almost  universal  custom  of  modern  govern- 
ments if  we  were  to  draw  the  greater  part  or  even 
the  whole  of  the  revenues  we  need  from  income 
taxes."  The  growing  appreciation  of  the  merits  of 
this  method  of  taxation,  coupled  with  the  increasing 
demand  for  public  revenue,  has  led  to  the  widespread 
adoption  of  the  income  tax.  and  it  now  forms  part 
of  the  fiscal  system  of  every  civilized  country  in  the 
world. 

In  one  form  or  another  income  tax  laws  are  n<.w 


INCOME  TAXES  15 

in  successful  operation  in  England,  Germany,  France, 
Belgium,  Denmark,  Norway,  Sweden,  Holland,  Italy, 
Switzerland,  Hungary,  India,  Japan,  Russia,  Hawaii, 
Canada,  New  Zealand,  Australia  and  the  United 
States,  or  in  some  of  the  states,  provinces  or  political 
subdivisions  of  these  countries.  These  several  laws 
differ  from  each  other  in  many  respects  but  they  all 
agree  in  making  income  the  basic  principle  and  meas- 
ure of  the  tax  paid.  Consideration  of  the  details  of 
these  various  laws  is  beyond  the  limits  and  purpose 
of  this  lecture  and  for  that  reason  the  discussion  is 
confined  to  the  laws  of  England  and  the  United 
States,  among  national  measures,  and  to  those  of 
Wisconsin  and  Massachusetts  among  the  states,  with 
only  incidental  reference  to  others.  It  is  believed 
that  these  income  tax  laws  are  typical  of  all  others. 

RIGHT  TO  ADOPT  INCOME  TAX 

The  power  of  taxation  is  an  attribute  of  sov- 
ereignty, inherent  in  every  government  unless  denied 
by  its  constitution.  This  power  is  legislative  in  char- 
acter and  may  be  exercised  upon  all  persons,  prop- 
erty, privileges  and  occupations  subject  to  legislative 
control,  1  Cooley  on  Taxation,  7;  McCullough  vs. 
Maryland,  4  Wheat.  316.  The  American  states  as 
independent  sovereignties,  also  possesss  this  power 
except  as  limited  by  the  federal  constitution,  Mich- 
igan Central  Ry.  vs.  Powers,  201  U.  S.  2-15,  and 
as  above  stated  many  of  them  have  exercised  it  by 
attempting  to  tax  incomes.  This  form  of  taxation  is 
now  in  force  in  the  states  of  Massachusetts,  Connec- 
ticut, Virginia,  South  Carolina,  Oklahoma,  West 
Virginia  and  Wisconsin. 


16  MODERN  AMERICAN  LAW  LECTURE 

Numerous  expressions  may  be  found  in  court  de- 
cisions to  the  effect  that  no  state  can  tax  income  de- 
rived from  interstate  commerce,  Steamship  Co.  vs. 
Pennsylvania,  122  U.  S.  326.  But  the  courts  have 
repeatedly  held  that  property  engaged  in  interstate 
commerce  may  be  taxed  by  the  states  provided  that  a 
reasonable  basis  of  apportionment  be  used  to  ascer- 
tain the  value  of  the  property  within  their  borders. 
Why  should  not  the  same  rule  apply  to  income  ?  If  one 
state  may  not  tax  income  from  interstate  commerce, 
no  other  can  do  so,  and  the  result  would  be  a  legal 
no  man's  land,  where  vast  organizations  may  operate 
relieved  from  the  burdens  which  others  are  com- 
pelled to  bear.  Of  course  neither  property  nor  in- 
come from  interstate  commerce  should  be  singled  out 
for  discrimination,  or  subjected  to  excessive  taxation ; 
but  no  reason  is  apparent  why  they  should  escape 
their  proper  share  of  the  common  burden. 

In  the  assessment  of  railroad  and  other  interstate 
property  under  the  property  tax,  the  common  prac- 
tice is  first  to  ascertain  the  value  of  the  entire  prop- 
erty as  a  unit  and  then  apportion  such  valuation 
among  the  several  states  according  to  mileage,  gross 
or  net  earnings,  or  a  combination  of  these  factors. 
In  the  administration  of  the  Wisconsin  income  tax 
law  the  same  principle  has  been  applied  to  the  assess- 
ment of  income  from  business  conducted  in  several 
states.  The  entire  income  from  all  sources  is  first  as- 
certained as  a  unit  and  then  distributed  to  Wisconsin 
in  the  proportion  which  the  property  located  and 
business  transacted  in  that  state  bears  to  the  total 
property  and  business  of  the  company.  The  United 


INCOME  TAXES  H 

States  Supreme  Court  has  never  directly  passed  upon, 
the  question,  but  an  assessment  'made  in  this  manner 
was  upheld  by  the  supreme  court  of  Wisconsin  in  the 
case  of  United  States  Glue  Co.  vs.  Town  of  Oak  Creek, 
161  Wis.,  211,  and  it  is  believed  that  the  practice  is? 
warranted  by  existing  law.  If  the  right  of  the  state?, 
to  tax  income  from  interstate  commerce  is  doubtful 
or  uncertain,  Congress  has  unquestioned  authority 
to  confer  it  upon  them. 

Another  limitation  growing  out  of  the  dual  nature 
of  the  federal  and  state  governments  is  the  lack  of 
power  on  the  part  of  either  to  tax  the  agencies  or 
instrumentalities  employed  by  the  other  in  carrying 
on  its  governmental  functions.  Thus  it  was  held 
under  the  civil  war  income  tax  law  that  the  United 
States  could  not  tax  the  salary  of  a  judge  of  a  state 
court  (Collector  vs.  Day,  11  Wallace,  113)  and,  con- 
versely, that  a  state  could  not  tax  the  salary  of  an 
officer  of  the  United  States  Government,  Dobbins 
vs.  Commissioners  of  Erie  County,  16  Peters,  435; 
Purnell  vs.  Page,  133  N.  C.  125.  The  same  principle 
prevents  a  state  from  taxing  income  from  United 
States  bonds,  and  the  United  States  from  taxing  in- 
come from  bonds  issued  by  a  state  or  any  of  its  politi- 
cal subdivisions.  Express  exemptions  to  this  effect 
are  contained  in  the  recent  federal  act  and  in  the 
Wisconsin  and  Massachusetts  laws.  Both  the  federal 
government  and  the  separate  states  may  tax  the  sal- 
aries of  their  own  officers  if  the  legislature  so  pro- 
vides and  it  is  common  practice  to  do  so  as  to  all 
officers  elected  after  the  enactment  of  the  law.  The 
right  to  tax  the  salary  of  a  circuit  judge  elected  prior 


18 

to  the  passage  of  the  income  tax  law  has  also  been 
upheld,  State  ex  rel  Wickham  vs.  Nygaard,  159  Wis. 
396. 

SCOPE  OP  INCOME  TAX  LAWS 

Subject  to  these  limitations  the  several  states  are 
as  free  to  adopt  income  tax  laws  as  the  federal  gov- 
ernment. In  doing  so  they  may  apply  the  tax  to  all 
income  received  by  their  own  residents,  or  to  all  in- 
come derived  from  sources  within  their  borders.  The 
former  is  the  more  common  practice.  Thus  the  fed- 
eral income  tax  law  expressly  provides  for  the  taxa- 
tion of  all  income  received  by  citizens  of  the  United 
States,  including  that  derived  from  foreign  coun- 
tries, and  also  so  much  of  the  income  of  non-residents 
or  aliens  as  is  derived  from  business  transacted  or 
property  located  in  this  country.  The  English  and 
German  income  tax  laws  are  to  the  same  effect.  The 
recent  Massachusetts  income  tax  law  makes  residence 
the  test  of  taxability  and,  with  perhaps  greater  con- 
sistency, confines  the  tax  to  income  received  by  resi- 
dents of  that  state,  excluding  income  derived  by  non- 
residents from  sources  within  the  state.  The  Wis- 
consin law  makes  the  source  of  income  the  test  and 
limits  the  application  of  the  tax  to  income  derived 
from  property  located  and  business  transacted  within 
its  borders,  whether  by  residents  or  non-residents. 

Even  where  the  source  of  income  is  made  the  test  of 
taxability,  compensation  for  personal  services,  inter- 
est from  securities  and  dividends  from  stocks  are 
taxed  at  the  residence  of  the  recipient  under  the  rule 
of  mobilia  sequuntur.  The  close  commercial  relations 


INCOME  TAXES  19 

and  the  principle  of  comity  between  the  states  stand 
in  the  way  of  one  state  taxing  all  income  of  its  own 
residents  and  also  that  of  non-residents  derived  from 
sources  within  its  borders,  as  is  done  by  the  federal 
statute.  To  do  so  involves  an  inconsistency  and  if 
all  states  were  to  adopt  a  system  of  income  taxation 
it  would  result  in  double  taxation  of  all  income  de- 
rived from  one  state  and  paid  to  residents  of  another. 
The  Massachusetts  rule  making  residence  the  sole 
test  of  taxability  and  excluding  income  passing  to  non- 
residents from  sources  within  the  state,  is  believed 
to  be  simpler  and  more  consistent. 

In  discussing  a  similar  question  in  a  recent  article 
Professor  Bullock  expressed  his  preference  for  that 
system  in  the  following  words : 

If  every  citizen  were  taxable  at  his  domicile  upon  his  entire 
income  without  exemption  or  deduction,  except  such  as  may  be 
proper  in  the  case  of  small  incomes,  and  if  then  all  tangible  prop- 
erty were  taxed,  under  a  proper  classification,  at  its  situs,  we 
should  have  the  simplest,  most  logical,  and  most  satisfactory  of 
all  solutions.  Everybody  would  pay  an  income  tax  in  the  locality 
where  he  lives  and  enjoys  the  benefits  of  government,  and  all  prop- 
erty would  contribute  to  the  support  of  the  jurisdiction  where  it 
receives  the  benefit  of  governmental  services.  The  former  tax 
would  necessarily  be  of  a  personal  character,  the  latter  would  be 
levied  purely  objectively  upon  things  without  regard  to 
ownership. 

WHAT  IS  INCOME? 

In  framing  or  construing  an  income  tax  law  the 
first  question  to  arise  is,  what  is  or  may  be  classified 
as  income  ?  Does  the  term  include  all  that  comes  in 
during  a  given  period  from  whatever  source,  or  is  it 
confined  to  earnings  of  person  and  property,  or  a 


20  MODERN  AMERICAN  LAW  LECTURE 

combination  of  these?  Are  sporadic  gains,  such  as 
gifts  and  inheritances,  or  appreciation  in  the  value  of 
property,  income?  Does  the  term  include  proceeds 
derived  from  the  sale  of  products  which  diminish 
and  eventually  exhaust  capital,  such  as  the  sale  of 
ore  from  mines,  or  standing  timber  from  lands  ?  Can 
it  be  applied  to  payments  received  under  an  annuity 
or  an  insurance  policy,  or  to  a  stock  dividend?  If 
some  or  all  of  these  are  to  be  treated  as  income,  to 
what  extent  are  deductions  to  be  allowed  for  impair- 
ment of  capital  ?  These  and  many  similar  questions 
confront  the  legislator  or  administrator  in  dealing 
with  this  form  of  taxation. 

The  Century  Dictionary  defines  income  as  "that 
which  comes  in  to  a  person  as  payment  for  labor  or 
services  rendered  in  some  office  or  as  gain  from  lands, 
business,  the  investment  of  capital,  etc. ;  receipts  or 
emoluments  regularly  accruing  either  in  a  given  time 
or,  when  unqualified,  annually." 

Professor  Seligman  says : 

Income  is  that  which  comes  in  to  an  individual  above  all  neces- 
sary expenses  of  acquisition  and  which  is  available  for  his  own 
consumption.  Since  the  income  is  a  flow  of  wealth  it  must  always 
be  estimated  for  a  definite  period  so  that  when  we  speak  of  income 
for  purposes  of  taxation  we  really  mean  annual  income.  Strictly 
speaking,  income  as  contrasted  with  capital  denotes  that  amount 
of  wealth  which  flows  in  during  a  definite  period  and  which  is  at 
the  disposal  of  the  owner  for  purposes  of  consumption  so  that  in 
consuming  it  his  capital  remains  unimpaired.  Seligman  on 
Income  Tax,  19. 

The  supreme  court  of  Georgia  expressed  this  dis- 
tinction figuratively  in  a  much  quoted  paragraph  as 
follows : 


INCOME  TAXES  21 

The  fact  is.  property  is  a  tree,  income  is  the  fruit :  labor  is  a 
tree,  income  the  fruit ;  capital  a  tree,  income  the  fruit.  The  fruit 
if  not  consumed  as  fast  as  it  ripens  will  germinate  from  the  seed 
which  it  encloses  and  will  produce  other  trees  and  grow  into  more 
property :  but  so  long  as  it  is  fruit  merely  and  plucked  to  eat  and 
consumed  in  the  eating,  it  is  no  tree  and  will  produce  itself  no 
fruit.  Waring  vs.  City  of  Savannah,  60  Georgia  93. 

It  will  be  seen  from  the  foregoing  that  "income" 
implies  something  apart  from  and  in  addition  to  capi- 
tal recurring  at  stated  intervals.  As  stated  by  Presi- 
dent Hadley  the  conception  underlying  capital  is  static 
and  independent  of  time  while  the  conception  underly- 
ing income  is  dynamic  and  involves  the  element  of 
time.  In  other  words,  capital  is  constant  and  fixed 
while  income  is  mobile  and  recurrent.  An  income  tax 
is  designed  to  reach  and  apply  to  the  income  only  leav- 
ing the  capital  unimpaired. 

Fortunately,  as  said  by  the  supreme  court  of  "Wis- 
consin, "we  are  not  called  upon  to  enter  the  wide 
and  somewhat  vague  field  of  what  the  term  *  income' 
means  in  the  technical  or  true  economic  sense  of  the 
word.  Income  as  used  in  constitutions  and  tax  stat- 
utes must  be  given  its  common  ordinary  meaning  and 
not  its  strict  technical  or  economic  meaning,"  Van 
Dyke  vs.  Milwaukee,  159  Wis.  460. 

For  the  purpose  of  an  income  tax  the  proper  definition  of  the 
word  would  be  ' '  all  that  a  man  receives  in  cash  during  the  year 
except  such  sums  as  are  merely  capital  or  principal  in  a  changed 
form,  that  is,  excluding  sums  which  are  merely  the  proceeds  of 
some  other  form  of  capital  converted  into  cash.  Black  on  Income 
Tans,  Section  221. 

The  use  of  the  word  "cash"  unduly  limits  the 
above  definition.  Income  in  its  general  sense  need 


22  MODERN  AMERICAN  LAW  LECTURE 

not  necessarily  be  money.  It  must  be  money  or  that 
which  is  convertible  into  money,  Income  Tax  Cases, 
148  Wis.  456.  The  rental  value  of  residence  prop- 
erty occupied  by  the  owner,  the  value  of  farm  pro- 
duce consumed  by  the  occupant,  and  the  value  of  sup- 
plies from  a  merchant's  stock  used  by  his  family,  are 
treated  as  income  under  nearly  all  income  tax  laws, 
Corke  vs.  Fry,  32  Scottish  Law  Reports,  341. 

Most  modern  income  tax  laws  use  the  words  "gains 
and  profits"  in  addition  to  "income"  in  declaring 
what  the  tax  shall  apply  to.  The  recent  federal  in- 
come tax  law  is  typical  in  this  respect  in  declaring 
that: 

The  net  income  of  a  taxable  person  shall  include  gains,  profits 
and  income  derived  from  salaries,  wages  or  compensation  for 
personal  service  of  whatever  kind  and  in  whatever  form  paid  or 
from  professions,  vocations,  businesses,  trade,  commerce,  or  sales, 
or  dealings  in  property  whether  real  or  personal,  growing  out  of 
the  ownership  or  out  of  interest  in  real  or  personal  property; 
also  from  interest,  rent,  dividends,  securities  or  the  transaction 
of  any  business  carried  on  for  gain  or  profit,  or  gains  or  profits 
and  income  from  any  source  whatever. 

ACCRETION  TO  CAPITAL 

Bearing  in  mind  that  capital  is  to  remain  intact, 
it  is  plain  that  the  proceeds  derived  from  the  sale  of 
a  farm,  a  factory,  or  a  mine  without  profit,  repre- 
sent a  mere  change  in  form  or  conversion  of  capital 
assets,  and  not  income  in  the  proper  sense.  Under 
early  income  tax  laws  the  tendency  was  to  limit  the 
term  "income"  to  profits  derived  from  personal  or 
business  activity  and  to  credit  appreciation  of  assets 
to  capital  account.  Accordingly  some  early  decisions 
held  that  appreciation  in  the  value  of  property  should 


INCOME  TAXES  23 

be  treated  as  addition  to  capital.  Thus  the  supreme 
court  of  the  United  States  in  the  case  of  Gray  vs. 
Darlington,  15  Wallace  63,  said  "the  mere  fact  that 
property  has  advanced  in  value  between  the  date  of 
its  acquisition  and  sale  does  not  authorize  the  impo- 
sition of  the  tax  on  the  amount  of  the  advance.  Mere 
advances  in  value  in  no  sense  constitute  the  gains, 
profits,  or  income  specified  by  the  statute.  It  consti- 
tutes and  can  be  treated  merely  as  increase  of  capi- 
tal." In  the  light  of  subsequent  decisions  it  is  be- 
lieved that  this  language  is  too  broad.  The  sole  ques- 
tion involved  in  that  case  was  as  to  whether  the  in- 
crease in  the  value  of  corporate  stock  held  for  a  period 
of  years  could  all  be  ascribed  to  the  year  in  which  the 
stock  was  sold.  The  court  properly  held  that  it  could 
not,  but  the  point  as  to  whether  so  much  of  the  in- 
crease as  accrued  during  the  year  of  the  assessment 
or  after  the  income  tax  law  was  enacted  was  not  in- 
volved and  the  decision  cannot  be  considered  as  au- 
thoritative on  that  point. 

The  recent  decision  of  the  United  States  Supreme 
Court  in  the  case  of  Von  Baumbach  vs.  Sargent  Land 
Company,  37  Supreme  Court  Reporter  201,  holding 
that  royalties  received  by  an  owner  of  mineral  land 
for  mining  and  extracting  ore  therefrom  constitute 
income  under  the  Corporation  Act  of  1909  and  are 
taxable  as  such  without  allowance  for  depreciation, 
and  the  English  case  of  Alianza  Company  vs.  Bell,  1 
Kings  Bench  184,  to  the  same  effect  indicate  a  relaxa- 
tion of  this  rule.  And  this  is  the  tendency  of  the  more 
recent  decisions,  Jarvis  on  British  Income  Tax. 

Both  the  income  tax  acts  of  1913  and  1916  expressly 


24  MODERN  AMERICAN  LAW  LECTURE 

provide  for  the  taxation  of  profits  from  capital  assets 
when  realized  in  sale  and  the  Wisconsin  and  Massa- 
chusetts income  tax  laws  have  similar  provisions. 
The  tax,  however,  applies  only  to  so  much  of  the 
profit  as  accrued  after  the  income  tax  law  was  enacted. 
Whatever  property  or  thing  of  value  the  taxpayer 
had  at  that  time  is  treated  as  capital  for  the  purpose 
of  determining  the  tax.  If  the  property  were  pur- 
chased prior  to  and  the  sale  occurred  after  the  enact- 
ment of  the  income  tax  law,  then  only  so  much  of  the 
profit  can  be  subjected  to  the  tax  as  accrued  during 
the  life  of  the  law,  State  ex  rel.  Bundy  vs.  Nygaard, 
163  Wis.  307.  If  the  value  of  the  property  at 
the  time  when  the  law  took  effect  can  be  definitely 
determined,  then  the  profit  will  be  computed  on  that 
basis.  In  the  absence  of  such  proof  of  value  the  fed- 
eral act  of  1913  and  the  Wisconsin  law  provide  for 
a  pro-rating  of  the  profit  in  the  proportion  which 
the  time  between  the  enactment  of  the  law  and  the 
date  of  sale  bears  to  the  total  length  of  time  the  in- 
vestment was  held.  Both  methods  are  designed  to 
determine  how  much  of  the  profit  accrued  after  the 
enactment  of  the  law  and  to  confine  the  tax  to  that 
amount.  Practically  all  authorities  agree  that  no 
part  of  the  increase  in  the  value  of  capital  assets 
which  accrued  prior  to  the  enactment  of  an  income 
tax  law  can  be  assessed  as  income.  To  do  so  would 
give  the  law  a  retroactive  effect. 

DISTRIBUTION  OF  SURPLUS 

Another  form  of  the  same  question  arises  when 
a  corporation  distributes  a  surplus  accumulated  prior 


INCOME  TAXES  25 

to  the  enactment  of  the  income  tax  law  to  its  stock- 
holders after  the  law  takes  effect.  Clearly  such  a 
surplus  cannot  be  taxed  to  the  corporation  direct 
because  there  was  no  income  tax  law  when  it  was 
earned.  Is  the  same  fund  taxable  when  distributed 
to  stockholders  in  the  form  of  dividends?  The  su- 
preme court  of  Wisconsin  answered  this  question  in 
the  affirmative  in  the  case  of  Van  Dyke  vs.  City  of 
Milwaukee,  supra,  on  the  ground  that  earnings  of  a 
corporation  are  not  income  to  stockholders  until  dis- 
tributed, but  that  such  dividends  become  income  to 
them  when  received. 

A  different  conclusion  was  reached  by  the  circuit 
court  of  appeals  for  the  Eighth  Circuit  in  the  case 
of  Lynch  vs.  Turrish,  236  Federal  Reporter,  653.  It 
was  there  held  that  all  surplus  on  hand  when  the 
act  of  1913  took  effect  represented  capital  and  that 
the  same  could  be  distributed  to  stockholders  free 
of  the  tax.  Notwithstanding  this  decision  the  inter- 
nal revenue  department  in  administering  the  act  of 
1913  continued  to  tax  dividends  declared  out  of  sur- 
plus in  harmony  with  the  "Wisconsin  rule,  but  the 
1916  revision  of  the  federal  act  removes  the  question 
by  providing 

"That  the  term  dividends  as  used  in  this  title  shall  be  held 
to  mean  any  distribution  made  or  ordered  to  be  made  by  a  cor- 
poration, joint  stock  company,  association,  or  insurance  company 
out  of  its  earnings  or  profits  accrued  since  March  1,  1913,  and 
payable  to  its  shareholders  whether  in  cash  or  in  stock  of  the 
corporation,  joint  stock  company,  association,  or  insurance  com- 
pany, which  stock  dividend  shall  be  considered  income  to  the 
amount  of  its  cash  value." 


26  MODERN  AMERICAN  LAW  LECTURE 

The  effect  of  this  amendment  is  to  limit  the 
taxation  of  increase  in  capital  assets  or  distribution 
of  surplus  to  such  part  of  the  fund  as  accrued  or  was 
earned  subsequent  to  the  enactment  of  the  1913  law. 

STOCK  DIVIDENDS 

A  closely  related  question  arises  in  the  case  of  the 
distribution  of  surplus  in  the  form  of  stock  dividends 
on  which  the  authorities  are  also  divided.  The  United 
States  Supreme  Court  has  uniformly  held  that  stock 
dividends  are  not  income  for  the  reason  that  after  a 
pro  rata  distribution  of  such  dividends  a  stockholder 
has  no  greater  interest  in  the  corporate  assets  than 
he  had  before,  and  that  in  consequence,  receipt  of  the 
stock  dividend  does  not  represent  either  profit  or  in- 
come, Gibbons  vs.  Mahon,  136  U.  S.,  549;  D'Ooge  vs. 
Leeds,  176  Mass.  558.  The  Supreme  Court  of  New 
York,  on  the  other  hand,  held  in  the  case  of  Lowry 
vs.  Farmers  L.  &  T.  Company,  172  N.  Y.  137,  and 
subsequent  decisions,  that  a  stock  dividend  is  income 
to  the  stockholder  when  received,  and  the  supreme 
court  of  Wisconsin  followed  the  New  York  rule  and 
criticized  the  federal  authorities  in  Soehnlein  vs. 
Soehnlein,  146  Wis.  330.  It  was  urged  in  the  latter 
decision  that  if  the  surplus  had  been  distributed  in 
the  form  of  cash  it  would  be  clearly  taxable  and  that 
there  is  no  substantial  difference  between  a  distribu- 
tion of  surplus  in  cash  and  in  the  form  of  stock  divi- 
dends ;  that  the  issue  of  the  stock  dividend  decreased 
the  net  assets  of  the  corporation  in  the  same  propor- 
tion that  the  stockholders'  interest  was  increased. 
Both  New  York  and  Wisconsin  adopted  this  rule  with 


INCOME  TAXES  27 

full  knowledge  of  the  contrary  rule  in  the  federal 
courts  and  the  conflict  is  irreconcilable.  Of  course 
the  federal  decisions  control  in  the  administration 
of  the  federal  income  tax  law,  but  the  state  courts  are 
at  liberty  to  follow  whichever  of  these  rules  they  deem 
advisable  in  the  construction  of  their  own  laws. 
The  federal  rule  is  probably  modified  by  the  1916 
amendment  above  quoted,  declaring  stock  dividends 
taxable  to  the  same  extent  and  under  the  same  condi- 
tions as  if  the  distribution  were  made  in  cash. 

INHERITANCES  AND  ANNUITIES 

A  further  question  arises  as  to  whether  irregular 
receipts,  such  as  gifts,  inheritances,  annuities  and  the 
proceeds  of  life  insurance  and  endowment  policies, 
are  taxable  as  income.  Logically  the  answer  would 
seem  to  depend  upon  the  question  whether  such  re- 
ceipts represent  a  return  of  capital  previously  in- 
vested or  not,  but  this  distinction  has  not  always  been 
observed  either  in  framing  or  construing  income  tax 
laws.  Annuity  and  endowment  payments  have  been 
held  taxable  under  the  English  income  tax  act,  but 
legacies  have  been  treated  as  an  addition  to  capital, 
Knowles  vs.  Me  Adam,  L.  R.  3  Ex.  Div.  23.  The  income 
tax  law  of  Hawaii  includes  "money  and  the  value  of 
all  personal  property  acquired  by  gift  or  inheri- 
tance," except  when  otherwise  taxed  as  such.  The 
Wisconsin  law  as  first  enacted  had  a  similar  pro- 
vision, but  by  later  amendment  gifts  and  inheritances 
are  exempt.  Both  the  federal  and  Massachusetts 
income  tax  laws  expressly  exclude  inheritances  and 
bequests  from  the  operation  of  the  law,  and  this  is 


28  MODERN  AMERICAN  LAW  LECTURE 

believed  to  be  the  general  rule.  Such  irregular  and 
sporadic  receipts  are  treated  as  additions  to  capital 
instead  of  income.  To  the  extent  that  purchased 
annuities  and  life  and  endowment  insurance  involve 
the  expenditure  of  capital,  the  proceeds  thereof  should 
not  be  taxed,  and  this  is  the  tendency  of  modern  legis- 
lation. 

The  rule  prescribed  by  the  Internal  Revenue  De- 
partment in  administering  the  present  income  tax 
law  is: 

"The  amount  paid  under  a  life  insurance  endow- 
ment or  annuity  contract  is  not  income  when  returned 
to  the  person  making  the  contract,  either  upon 
the  maturity  or  surrender  of  the  contract;  but 
the  amount  by  which  the  sum  received  exceeds  the  sum 
paid  and  coming  into  the  hands  of  the  person  making 
the  contract  and  payment  is  income." 

The  Wisconsin  income  tax  act  provides  that  "  en- 
dowments or  other  insurance  paid  to  the  insured  in  his 
lifetime  shall  be  taxable  upon  the  excess  received  over 
the  amount  paid  for  the  insurance."  In  other  words, 
the  tax  applies  only  to  the  profit  element  of  the  trans- 
action. The  Massachusetts  law  has  no  express  pro- 
vision on  the  subject  and  no  administrative  rule  has 
thus  far  been  published. 

NET  INCOME 

"  As  the  basic  principle  of  an  income  tax  is  to  gradu- 
ate the  burden  according  to  the  taxpayer's  ability  to 
pay,  it  necessarily  follows  that  the  tax  should  be  com- 
puted according  to  his  net  income.  Such  ability  de- 
pends upon  his  gains  and  profits  for  the  year  and 


INCOME  TAXES  29 

these  cannot  be  measured  by  his  gross  income  until 
compared  with  the  expense  involved  in  producing  it. 
Accordingly  all  modern  income  tax  laws  use  net  in- 
come as  the  basis  of  the  tax  and  this  is  arrived  at  by 
deducting  from  the  gross  income  for  the  year  cov- 
ered by  the  return  the  ordinary  expenses  incurred 
in  producing  it.  Broadly  speaking,  these  expenses 
include  the  cost  of  labor,  material  and  goods,  freight, 
cartage,  rent,  taxes,  insurance,  interest,  depreciation 
and  repairs  and  all  other  expenses  necessarily  inci- 
dent to  carrying  on  the  business.  Bad  debts  pre- 
viously reported  as  income  and  other  losses  arising 
out  of  the  business  conducted  are  also  deductible  but 
no  deductions  are  allowed  as  compensation  for  per- 
sonal services  of  the  person  reporting,  nor  for  ex- 
penses of  a  personal  character,  as  those  are  covered 
by  his  exemptions.  Corporations  are  allowed  to  de- 
duct reasonable  salaries  paid  to  officers  in  determin- 
ing their  net  income,  but  the  latter  are  taxable  upon 
such  salaries  in  their  individual  capacity. 

As  a  condition  of  deducting  wages  and  salaries 
under  the  Massachusetts  and  Wisconsin  laws,  the 
employer  is  required  to  report  the  names  and  amounts 
paid  to  each  person  employed  by  him,  and  the  same 
rule  applies  in  the  case  of  payments  for  interest  and 
rent.  Failure  or  refusal  to  furnish  such  list  will  de- 
feat the  deduction.  The  purpose  of  this  provision  is 
to  serve  as  a  check  on  the  persons  receiving  the  pay- 
ment in  the  assessment  of  their  income  by  taxing  offi- 
cials. It  is  designed  as  a  substitute  for  the  principle 
of  collection  at  the  source  prescribed  by  the  Eng- 
lish and  Federal  income  tax  laws. 


30  MODERN  AMERICAN  LAW  LECTURE 

LOSSES 

As  a  general  rule  deductions  for  losses  are  confined 
to  those  incurred  in  the  trade  or  business  producing 
the  income  and  such  as  result  from  physical  causes. 
The  Federal  income  tax  act  provides  for  the  deduc- 
tion of  "losses  actually  sustained  during  the  year 
incurred  in  his  business  or  trade  or  arising  from  fires, 
storms,  shipwreck  or  other  casualty  and  from  theft, 
when  such  losses  are  not  compensated  for  by  insur- 
ance or  otherwise."  The  provisions  of  the  Hawaiian 
and  Wisconsin  laws  are  not  thus  restricted,  but  con- 
sidering their  purpose,  namely,  to  impose  a  tax  on 
income,  not  on  property  or  capital,  it  is  believed  that 
they  should  have  the  same  construction. 

Black  on  Income  Taxes,  section  304,  says:  "Ap- 
parently the  legislative  purpose  was  to  include  those 
losses  which  are  incident  to  the  business  out  of  which 
the  taxable  income  is  produced  or  such  as  involve  the 
destruction  or  impairment  of  property  employed  or 
capital  invested  in  that  business."  This  distinction 
is  important  where  the  entire  income  is  not  subject 
to  the  tax,  as  under  the  Wisconsin  law.  To  meet  this 
situation  the  Wisconsin  Tax  Commission  adopted  the 
following  rule: 

It  is  believed  that  the  legislature  intended  the  provisions  of  the 
law  relating  to  the  assessment  of  income  and  deduction  of  losses 
to  be  correlative,  and  that  a  loss  resulting  from  a  given  transac- 
tion should  not  be  allowed  as  a  deduction  unless  the  profit  there- 
from, if  one  had  been  realized,  could  be  taxed  as  income.  This 
rule  prohibits  the  deduction  of  losses  resulting  from  business 
transacted  without  the  state  the  profit  from  which  could  not  be 
taxed  if  one  had  been  realized. 


INCOME  TAX:  31 

The  present  Federal  income  tax  act  authorizes  the 
deduction  of  losses  resulting  from  transactions  not 
connected  with  the  business  or  trade  producing  the 
income  but  only  to  the  extent  of  the  income  derived 
therefrom.  Mere  fluctuation  in  the  value  of  property 
is  neither  taxable  as  income  nor  deductible  as  loss 
until  the  amount  is  determined  by  sale  or  other  final 
disposition  of  the  property,  even  though  evidenced 
by  book  entry.  The  loss  is  not  "actually  sustained" 
within  the  meaning  of  the  law  until  the  amount  has 
disappeared  from  the  assets  of  the  person  reporting 
as  the  result  of  a  completed,  closed  transaction, 
Foster's  Income  Tax,  Sec.  68. 

INTEREST 

Natural  persons  are  generally  allowed  full  deduc- 
tion of  all  interest  paid  by  them  during  the  year  cov- 
ered by  their  returns.  Under  the  Federal  corpora- 
tion act  of  1909.  deduction  of  interest  was  limited 
to  the  amount  payable  on  an  indebtedness  not  exceed- 
ing the  capital  stock  of  the  corporation.  The  Wis- 
consin law  contains  a  similar  provision.  The  pur- 
pose of  this  limitation  was  to  prevent  the  practice  of 
low  capitalization  and  large  bond  issues  and  the  con- 
sequent distribution  of  earnings  in  the  form  of  in- 
terest not  subject  to  the  tax,  and  it  was  sustained  on 
that  ground  in  the  case  of  Anderson  vs.  42  Broadway, 
239  U.  S.  69.  The  1916  revision  of  the  Federal  act 
modifies  this  limitation  by  pemn'tting  deduction  of 
interest  on  an  indebtedness  equal  to  the  paid  up  cap- 
ital stock  outstanding  at  the  close  of  the  year  and 
one-half  of  its  interest-bearing  indebtedness,  with 


32  MODERN  AMERICAN  LAW  LECTURE 

the  further  proviso  that  full  deduction  shall  be 
allowed  to  corporations  dealing  in  securities  pledged 
as  collateral. 

As  interest  is  a  necessary  outlay  for  those  doing 
business  on  credit  it  would  seem  proper  to  allow  full 
deduction  of  all  interest  paid  on  indebtedness  in- 
curred in  carrying  on  the  business  producing  the  in- 
come as  in  the  case  of  insurance  and  taxes. 

DEPRECIATION 

All  income  tax  laws  provide  for  deduction  of  a 
reasonable  allowance  for  depreciation  of  the  property 
used  and  employed  in  producing  the  income.  The 
amount  of  such  depreciation  depends  upon  the  nature 
and  use  of  the  property  and  its  probable  life.  The 
underlying  idea  is  to  provide  a  fund  sufficient  to  re- 
place the  property  or  its  original  cost  when  it  becomes 
unfit  for  use,  so  as  to  leave  the  capital  unimpaired. 
En  addition  to  allowance  for  the  ordinary  use  and 
wear  and  tear  of  property  the  Federal  income  tax 
act,  as  revised  in  1916,  further  allows  for  exhaustion 
"In  the  case  of  mines  a  reasonable  allowance  for 
depletion  thereof,  not  to  exceed  the  market  value  in 
the  mine  of  the  product  which  has  been  mined  and 
sold  during  the  year  for  which  the  return  is  made, 
under  rules  to  be  prescribed  by  the  Secretary  of  the 
Treasury,"  but  when  such  allowance  equals  the  capi- 
tal originally  invested  no  further  depreciation  is  per- 
mitted. No  deduction  for  exhaustion  or  depletion 
in  the  case  of  mineral  properties  was  provided  by  the 
Federal  corporation  act,  under  which  the  decision  in 
the  case  of  Von  Baumbach  vs.  Sargent  Land  Co., 


INCOME  TAXES  33 

supra,  was  rendered,  and  therefore  the  rule  laid  down 
in  that  case  is  not  authoritative  under  the  present 
Federal  income  tax  law. 

DEDUCTION  OF  DIVIDENDS 

In  the  case  of  dividends  received  from  corpora- 
tions it  is  common  to  relieve  the  stockholder  from 
the  tax  to  the  extent  that  the  corporation  has  paid  it. 
The  payment  of  such  tax  by  the  corporation  operates 
to  reduce  the  earnings  available  for  distribution,  and 
to  charge  the  stockholders  again  would  be  in  effect 
double  taxation.  Both  Federal  and  State  statutes  pro- 
vide against  this  result.  Under  the  Federal  law  the 
corporation  is  charged  with  the  normal  tax  only  and 
stockholders  receiving  dividends  are  entitled  to  an 
abatement  or  deduction  to  that  extent.  Under  the 
Wisconsin  law  the  entire  tax  is  charged  to  the  corpo- 
ration and  therefore  the  dividend  passes  tax  free  to 
the  stockholder.  The  obvious  purpose  of  this  statute 
is  to  prevent  double  taxation  and  no  difficulties  arise 
where  the  entire  income  of  the  corporation  is  taxed ; 
but  where  only  part  of  the  corporate  income  is  tax- 
able it  becomes  necessary  to  prorate  the  deduction  so 
as  to  relieve  the  stockholder  from  payment  on  only 
that  portion  of  his  dividend  which  has  already  been 
taxed  to  the  corporation. 

HOLDING  COMPANIES 

Under  the  present  Federal  law  the  right  to  deduct 
dividends  is  limited  to  individual  stockholders  and 
is  not  allowed  to  corporations  owning  stock  in  other 
corporations  known  as  holding  companies.  The  TVis- 


34  MODERN  AMERICAN  LAW  LECTURE 

consin  law  has  no  such  limitation  and  authorizes  the 
deduction  of  dividends  received  from  corporations 
"the  income  of  which  shall  have  been  assessed  under 
the  provision  of  this  act."  When  the  parent  cor- 
poration distributes  a  dividend  to  a  corporation 
stockholder  the  deduction  is  allowed  in  full,  but  when 
the  latter  corporation  in  turn  distributes  the  same 
income  to  its  stockholders  a  question  has  arisen  as 
to  whether  the  deduction  should  be  allowed.  While 
the  Wisconsin  law  does  not  in  terms  confine  the  de- 
duction to  dividends  received  from  a  corporation 
which  has  actually  been  taxed,  it  is  believed  that  it 
should  receive  that  construction.  Accordingly,  the 
Federal  rule  has  been  followed  in  this  respect  and  a 
case  is  now  pending  in  the  Wisconsin  supreme  court 
involving  the  validity  of  such  an  assessment. 

EXEMPTIONS 

When  net  income  is  determined,  as  above  outlined, 
the  rate  is  seldom  applied  to  the  entire  amount.  By 
common  usage  some  portion  of  the  income  is  relieved 
from  the  tax  by  means  of  an  exemption  or  abatement. 
These  exemptions  vary  in  form  and  amount  in  differ- 
ent countries  and  sometimes  in  different  parts  of  the 
same  country,  according  to  industrial  and  economic 
conditions,  the  prevailing  standard  of  living,  and  the 
nature  and  source  of  the  income  taxed.  But  they  all 
agree  on  the  basic  principle  of  excluding  such  part 
of  the  net  income  from  the  operation  of  the  tax  as 
is  deemed  "equivalent  to  that  needed  to  support  a 
family  in  the  very  lowest  scale  of  decent  subsistence," 


INCOME  TAXES  35 

commonly  called  the  "minimum  of  subsistence," 
Seligman  on  Income  Tax,  p.  27.  Obviously  it  would 
be  both  useless  and  illogical  to  require  the  payment 
of  a  tax  from  a  person  whose  income  is  not  sufficient 
for  his  own  support  and  who  may  in  turn  become  a 
charge  upon  the  public.  Accordingly  the  common 
practice  is  to  exempt  from  the  operation  of  the  law 
either  a  uniform  part  of  the  net  income  of  all  tax- 
payers or  varying  amounts  graduated  according  to 
the  size  of  the  income  or  the  source  from  which  de- 
rived. A  flat  exemption  is  the  common  practice  in  the 
United  States,  while  in  England  and  other  European 
countries  the  system  of  graduated  exemptions  or 
abatements  prevails. 

The  Federal  income  tax  law  provides  a  uniform 
exemption  of  $3,000  for  an  unmarried  adult  and 
$4,000  for  husband  and  wife,  without  additional 
allowance  for  children  or  dependents.  The  exemp- 
tions under  the  Wisconsin  law  are  $800  for  unmar- 
ried adults,  $1200  for  husband  and  wife,  $200  addi- 
tional for  each  child  under  18  years  of  age,  and  a  like 
amount  for  each  dependent  supported  by  the  tax- 
payer. The  general  exemption  under  the  Massachu- 
setts law  is  $500  for  husband  or  wife  and  $250  for 
each  child  under  18  years  of  age,  and  the  same  amount 
for  dependents,  but  in  no  case  to  exceed  $1,000.  The 
graduated  principle  is  introduced  by  denying  exemp- 
tion altogether  in  the  case  of  income  derived  from 
intangibles,  except  where  the  aggregate  income  is  less 
than  $600,  in  which  case  an  exemption  of  $300  is 
allowed,  and  by  allowing  an  exemption  of  $2,000  in 
the  case  of  income  derived  from  professions,  employ- 


36  MODERN  AMERICAN  LAW  LECTURE 

ments,  trade  or  business.  Substantially  the  same  re- 
sult is  reached  by  varying  the  tax  rate  on  income 
derived  from  different  sources. 

While  both  exemptions  and  rates  under  the  Eng- 
lish income  tax  law  are  annually  revised  by  parlia- 
ment, by  common  practice  an  exemption  of  150 
pounds,  or  about  $750  in  United  States  money,  has 
been  allowed  in  times  of  peace.  Rates  and  exemptions 
are  further  modified  as  to  income  derived  from  differ- 
ent schedules  under  the  English  law.  An  exemption 
of  $1,000  is  allowed  under  the  Virginia  and  Hawaiian 
income  tax  laws  and  $3000  under  the  Oklahoma  law. 
The  French  income  tax  act,  adopted  by  the  Chamber 
of  Deputies  in  1907,  further  varied  the  exemptions 
according  to  the  cost  of  living  in  different  districts, 
thus  higher  exemptions  were  allowed  in  the  districts 
containing  the  larger  cities  like  Paris  and  Lyons  than 
in  villages  and  rural  districts. 

As  corporations  have  no  physical  needs  and  are 
not  subject  to  the  infirmities  of  natural  persons,  no 
exemptions  are  allowed  to  them,  and  the  same  is  true 
of  partnerships  when  taxable  as  such.  Nearly 
all  income  tax  laws  exempt  the  income  of  charit- 
able, educational,  religious,  scientific,  civic  and 
like  organizations  not  conducted  for  pecuniary 
profit. 

In  general  it  may  be  said  that  exemptions  in  the 
United  States  are  more  liberal  than  those  allowed  in 
foreign  countries.  This  results  from  the  higher 
standard  of  living  among  the  industrial  classes  in  this 
country  and  the  greater  purchasing  power  of  the 
monetary  unit  in  Europe.  The  practice  of  granting 


INCOME  TAXES  37 

exemptions  was  sharply  criticised  during  the  early 
period  of  income  taxation,  but  exemptions  have  be- 
come a  fixed  feature  of  all  modern  income  tax  laws 
and  if  reasonable  in  amount  are  generally  approved 
by  present  day  economists.  The  balance  remaining 
after  deducting  expenses  and  exemptions  from  the 
gross  income  for  the  year,  represents  the  taxable 
income  or  the  amount  to  which  the  rate  is  applied. 

RATE  OF  TAXATION 

This  taxable  income  may  be  all  subjected  to  the 
same  rate,  in  which  case  it  is  said  to  be  proportional, 
or  the  rate  may  vary  according  to  the  source  or 
amount  of  the  income,  when  it  is  said  to  be  pro- 
gressive. The  proportional  rate  was  common  in  early 
income  tax  laws,  but  is  gradually  giving  way  to  a  pro- 
gressive rate  graduated  according  to  the  size  of  the 
income  taxed ;  and  in  many  cases  the  rates  also  vary 
according  to  the  nature  of  the  income  or  source  from 
which  it  is  derived.  A  common  practice  is  to  prescribe 
a  base  rate  for  all  incomes  below  a  given  amount,  say 
$1,000,  and  increase  this  rate  by  steps  of  fixed 
amounts  of  taxable  income  until  a  maximum  is 
reached.  Thus  the  rate  under  the  Wisconsin  income 
tax  law  is  fixed  at  one  per  cent,  on  the  first  thousand 
dollars  of  taxable  income  and  increases  by  steps  of 
one-quarter  of  one  per  cent,  for  each  additional  thou- 
sand until  the  fifth  thousand  dollars  is  reached,  and 
then  by  steps  of  one-half  of  one  per  cent,  up  to 
$11,000,  when  a  flat  or  proportional  rate  of  six  per 
cent,  applies. 


38  MODERN  AMERICAN  LAW  LECTURE 

The  base  rate  under  the  Federal  income  tax  of  1916 
is  two  per  cent,  on  all  taxable  income,  with  an  addi- 
tional or  supertax  of  one  per  cent,  on  taxable  income 
between  $20,000  and  $40,000;  two  per  cent,  between 
$40,000  and  $60,000;  three  per  cent,  between  $60,000 
and  $80,000;  four  per  cent,  between  $80,000  and 
$100,000;  five  per  cent,  between  $100,000  and  $150,- 
000,  and  so  continuing  by  increasing  steps  until  a  13 
per  cent,  supertax  is  imposed  on  taxable  income  ex- 
ceeding $2,000,000.  The  aggregate  rate,  therefore, 
ranges  from  a  minimum  of  two  per  cent,  on  taxable 
income  below  $20,000  to  a  maximum  of  15  per  cent, 
on  income  exceeding  $2,000,000.  Both  rates  and 
abatements  under  the  English  act  vary  from  year 
to  year  with  the  revenue  demands  of  the  empire.  For 
several  years  prior  to  the  commencement  of  the  pres- 
ent war  the  rates  averaged  about  one  shilling  on  the 
pound,  or  five  per  cent.,  except  as  modified  by  abate- 
ments. Since  the  commencement  of  the  war  the  pro- 
gression has  been  accelerated  and  the  rates  increased 
not  only  in  England  but  in  all  the  belligerent  coun- 
tries, and  now  reach  as  high  as  25  or  40  per  cent,  on 
large  incomes  in  certain  lines  of  business. 

The  British  lawr  has  always  differentiated  between 
earned  and  unearned  incomes,  applying  a  higher  rate 
to  the  latter  than  to  the  former.  Earned  income  in- 
volves the  element  of  personal  effort  or  exertion, 
while  unearned,  or,  as  Gladstone  called  it,  "lazy" 
income  is  the  product  or  yield  of  property  or  business. 
Accordingly  the  rate  applied  to  income  from  real 
estate,  trade  or  commerce  is  higher  than  that  applied 
to  salaries  and  wages  derived  from  personal  effort. 


INCOME  TAXES  3$ 

The  same  distinction  is  observed  in  the  recent  Massa- 
chusetts income  tax  act,  which  prescribes  a  rate  of 
six  per  cent,  on  income  from  intangibles,  as  compared 
with  one  and  one-half  per  cent,  on  compensation  for 
personal  services  and  income  derived  from  trade. 

In  early  discussions  of  the  income  tax  progressive 
rates  were  severely  criticised,  but  this  opposition  has 
gradually  subsided  and  practically  every  modern  in- 
come tax  law  embodies  this  principle.  The  decisions 
of  the  United  States  supreme  court  in  the  case  of 
Magoun  vs.  Illinois  T.  &  S.  Bank,  170  U.  S.  283, 
upholding  a  graduated  inheritance  tax  law,  and  the 
more  recent  case  of  Union  Pacific  vs.  Bushaber,  240 
U.  S.,  upholding  the  income  tax  law  of  1913,  fully 
established  the  validity  of  graduated  rates.  The  prac- 
tice is  justified  on  the  ground  of  the  relatively  greater 
ability  and  lesser  sacrifice  of  those  receiving  large 
incomes  to  contribute  to  public  support  than  those 
whose  incomes  are  close  to  the  niiniinuni  of  subsist- 
ence. The  widow's  mite  still  involves  more  sacrifice 
than  the  rich  man's  largess,  "for  he  pays  out  of  his 
abundance  but  she  out  of  her  want." 

ADMINISTRATION 

One  of  the  most  important  feature?  of  an  income 
tax  law  is  the  machinery  provided  for  its  adminis- 
tration. Local  officers  have  the  advantage  of  more 
intimate  acquaintance  with  taxpayers  and  of  the 
probable  amount  of  their  income,  but  the  grade  of 
ability  available  is  generally  of  a  lower  order  and 
administration  is  likelv  to  suffer  from  weakness  and 


40 

favoritism.  Satisfactory  results  have  been  obtained 
from  a  combination  of  the  two,  as  in  England  and 
Germany,  where  local  officers  make  the  initial  list,  but 
their  assessments  are  subject  to  supervision  and  re- 
view by  central  authority.  In  England  local  magis- 
trates make  the  preliminary  assessment  under  the 
supervision  of  a  surveyor  of  taxes,  but  their  work  is 
subject  to  review  by  Assessors  for  Affairs  of  Taxes 
and  the  Land  Tax  Commissioners  appointed  by  the 
crown.  A  similar  system  prevails  in  Germany,  but 
in  both  cases  the  supervision  and  final  determina- 
tion of  assessments  are  under  the  control  of  cen- 
tral authorities.  Administration  of  all  our  Federal 
income  tax  laws  has  been  vested  in  the  Internal  Reve- 
nue Department,  representing  a  completely  central- 
ized administration. 

All  experience  demonstrates  the  futility  of  commit- 
ting the  administration  of  income  tax  laws  to  locally 
elected  officers  and  confirms  the  necessity  of  strong 
centralized  supervision.  The  early  state  income  tax 
laws  of  this  country  were  administered  by  the  prop- 
erty tax  assessors  and  the  result  proved  very  unsatis- 
factory. The  practical  failure  of  all  state  income 
tax  laws  prior  to  that  of  Wisconsin,  enacted  in  1911, 
is  traceable  to  this  defect. 

Administration  is  further  differentiated  according 
as  the  taxpayer  is  authorized  to  determine  his  own 
income  or  is  assessed  by  officers  appointed  for  the 
purpose.  Voluntary  disclosure,  subject  to  review,  is 
the  prevailing  system  in  England,  while  Germany  is 
a  striking  illustration  of  official  assessments.  Under 
the  Federal  law  taxpayers  are  required  to  make  full 


INCOME  TAXES  41 

disclosure  of  the  amount  and  sources  of  their  income 
on  forms  prescribed  by  the  Revenue  Department. 
The  same  practice  prevails  in  Wisconsin  and  under 
the  recent  Massachusetts  law,  but  the  returns  so  made 
are  subject  to  audit  and  final  assessment  by  officers 
chosen  for  the  purpose.  Penalties  are  prescribed  for 
failure  or  refusal  to  make  return,  and  false  or  fraud- 
ulent statements  are  subject  to  punishment  by  fine 
or  imprisonment. 

Under  the  English  system  the  principle  of  collec- 
tion at  the  source  is  widely  utilized  and  our  Federal 
income  tax  law  embodies  the  same  principle.  Under 
this  system  fiduciaries  and  other  persons  making  sub- 
stantial payments  in  the  form  of  salaries,  interest, 
dividends,  rents  and  the  like  are  required  to  with- 
hold the  tax  chargeable  to  the  recipient  and  pay  the 
same  to  the  government.  As  the  taxpayer's  income 
from  other  sources  and  the  amount  of  his  exemptions 
must  be  known  in  order  to  compute  the  tax  accu- 
rately, this  provision  greatly  complicates  adminis- 
tration and  imposes  a  considerable  burden  upon  fidu- 
ciaries and  employers  of  labor.  As  above  pointed 
out,  the  Wisconsin  and  Massachusetts  laws  substi- 
tute information  at  the  source  for  collection  at  the 
source  as  a  condition  of  securing  the  deduction.  The 
pui'pose  is  the  same  in  each  case,  namely,  to  insure 
full  payment  of  the  tax  to  the  public.  It  is  believed 
that  the  system  of  information  at  the  source  is  sim- 
pler and  quite  as  effective  as  collection  at  the  source, 
while  it  avoids  many  complications  which  the  latter 
involves. 


42  MODERN  AMERICAN  LAW  LECTURE 

COLLECTION 

When  the  tax  is  finally  computed  the  collection  is 
usually  made  in  the  same  manner  as  in  the  case  of 
other  taxes.  Where  the  proceeds  are  designed  for  the 
central  government,  payment  is  made  to  the  national 
treasury  through  its  subordinate  branches  and  no  dis- 
tribution is  required.  If,  however,  the  tax  is  designed 
for  local  purposes,  as  in  Wisconsin,  it  must  be  dis- 
tributed among  the  districts  from  which  the  income 
was  received.  As  data  for  this  purpose  must  be  dis- 
closed in  the  return  the  forms  required  are  necessar- 
ily more  complicated  than  in  the  case  of  a  national 
tax. 

OPERATION  OP  INCOME  TAX 

The  conventional  criticism  of  the  income  tax  is 
that  it  is  all  right  in  theory  but  will  not  work  in  prac- 
tice. If  this  criticism  is  well  founded  it  constitutes 
a  fatal  objection  to  this  form  of  taxation.  In  last 
analysis  a  fiscal  system  must  be  tested  by  results,  and 
the  important  question  is  how  the  income  tax  actually 
operates  in  practice.  The  first  and  most  obvious  test 
of  a  tax  system  is  its  power  to  produce  revenue,  and 
the  income  tax  has  completely  met  this  test.  This  is 
shown  by  the  fact  that  the  yield  of  the  tax  in  England 
and  Germany  before  the  present  war  broke  out 'ex- 
ceeded $200,000,000  annually  in  each  country.  The 
assessment  of  1915  income  by  the  Internal  Revenue 
Department  at  the  relatively  low  rates  prescribed  by 
the  act  of  1913  resulted  in  a  tax  of  $124,937,252.  In 
Wisconsin  the  assessment  of  incomes  for  the  same 
year  produced  a  tax  of  $5,344,303.  It  is  estimated 


INCOME  TAXES  43 

that  the  average  annual  income  of  the  people  of  the 
United  States  from  all  sources  is  over  $30,000,000,000 
and  that  twenty  per  cent,  of  the  heads  of  families 
receive  forty-seven  per  cent,  of  this  amount  and  that 
two  per  cent,  of  them  receive  more  than  twenty  per 
cent,  of  it,  King's  Wealth  and  Income,  132.  The  In- 
ternal Revenue  Department  reports  that  one  hundred 
twenty  persons  in  the  United  States  received  an  in- 
come of  more  than  $1,000,000  each  in  1915  and  that 
the  aggregate  taxable  income  assessed  for  that  year 
was  $8,703,068,389.  These  figures  amply  demonstrate 
the  possibilities  of  this  f  orm  of  taxation  as  a  revenue 
producer. 

A  TAX  ON  WEALTH 

A  study  of  the  returns  under  income  tax  laws  con- 
clusively shows  that  the  income  tax  is  a  tax  on  the 
rich  and  well-to-do.  The  liberal  exemptions  allowed 
by  the  Federal  law  exclude  the  great  bulk  of  the  pop- 
ulation from  its  operation.  According  to  the  report 
of  the  Internal  Revenue  Department  only  about  one- 
half  of  one  per  cent,  of  the  population  is  subject  to 
the  tax.  In  Wisconsin,  with  lower  exemptions,  less 
than  three  per  cent,  of  the  population  come  within 
the  law.  Further  analysis  of  the  returns  indicates 
that  the  limited  number  receiving  large  incomes  pay 
most  of  the  tax.  Thus  329  out  of  a  total  of  366,443 
persons  assessed  under  the  Federal  income  tax  law 
in  1916  paid  about  one-fifth  of  the  total  tax.  In  Wis- 
consin 62  persons  receiving  an  income  of  over  $50,000 
each  paid  twenty-three  per  cent,  of  the  tax  assessed 
against  individuals,  and  14  out  of  an  aggregate  of 


44  MODERN  AMERICAN  LAW  LECTURE 

62,272  taxpayers  representing  only  one-two-hun- 
dredth of  one  per  cent,  of  the  total  number  paid  over 
twelve  per  cent,  of  the  tax.  In  the  county  of  Dane, 
in  which  the  capital  is  located,  three  individuals  re- 
ceiving an  income  of  over  $25,000  each  paid  one  and 
one-half  times  as  much  tax  as  the  2,250  persons 
having  less  than  $1,000  income  apiece. 

Where  the  earnings  of  corporations  are  assessed 
at  the  full  progressive  rate  as  in  Wisconsin,  they  pay 
the  bulk  of  the  tax.  The  aggregate  tax  assessed 
under  the  Wisconsin  law  on  1915  income  was  $5,344,- 
393,  and  of  this  amount  corporations  were  assessed 
for  $2,724,466,  or  seventy  percent,  of  the  total.  While 
corporations  paid  only  the  normal  rate  of  one  per 
cent,  prescribed  by  the  Federal  law  of  1913,  their 
aggregate  tax  according  to  the  last  assessment  was 
$56,993,658,  or  about  forty-five  per  cent,  of  the  total. 
If  the  income  of  these  corporations  had  been  subject 
to  the  full  tax  prescribed  for  individuals  under  the 
same  act,  the  yield  would  probably  have  been  five 
times  that  amount.  The  total  number  of  corpora- 
tions assessed  in  Dane  County  for  income  of  1915 
was  334,  and  the  total  tax  thereon  $133,939,  and  one 
corporation  engaged  in  the  production  of  war  mate- 
rial paid  $67,642,  or  more  than  one-half  of  this  total. 
As  enterprises  of  this  character  are  generally  located 
in  cities,  it  follows  as  a  corollary  that  the  yield  of 
the  income  tax  is  primarily  derived  from  urban  cen- 
ters. The  liberal  exemptions  and  relatively  small  in- 
come received  by  agricultural  classes  practically 
exempt  them  from  the  operation  of  the  law. 


INCOME  TAXES  45 

COMPARED  WITH  PERSONAL  PROPERTY  TAX 

Comparison  of  the  amount  of  taxes  paid  by  a 
selected  group  of  taxpayers  under  the  Wisconsin  act 
in  1912  with  the  personal  property  tax  paid  by  the 
same  persons  in  the  preceding  year  clearly  shows  the 
superiority  of  the  income  tax  as  applied  to  certain 
classes  of  the  community.  Thus,  25  lawyers  included 
in  this  group  paid  an  income  tax  of  $12,360  in  1912 
as  compared  with  a  personal  property  tax  of  $4,237 
in  1911 ;  21  other  professional  men  paid  an  income 
tax  of  $9,137  for  that  year  as  compared  with  per- 
sonal property  taxes  of  $811  the  preceding  year ;  40 
brokers,  salesmen  and  solicitors  paid  an  income  tax 
of  $13,974  in  1912,  as  against  a  property  tax  of  $1,803 
in  1911.  And  17  capitalists  whose  personal  property 
tax  was  $1,448  in  1911  paid  an  income  tax  of  $13,233 
in  1912.  These  figures  clearly  show  the  unequal  oper- 
ation of  the  personal  property  tax  and  the  greater 
efficiency  of  the  income  tax  in  securing  contribution 
from  those  who  are  best  able  to  pay.  Many  lines  of 
business  yielding  profitable  returns  require  little 
property  to  carry  them  on.  Those  engaged  in  such 
business  enjoy  the  protection  of  law  and  the  benefits 
of  government  without  corresponding  contribution  to 
its  support.  To  the  extent  that  the  income  tax 
reaches  this  source  of  revenue,  it  operates  to  equalize 
public  burdens. 


46  MODERN  AMERICAN  LAW  LECTURE 

OBJECTIONS  TO  INCOME  TAX 

Complaint  is  often  heard  that  the  income  tax  is  a 
class  tax  for  the  reason  that  so  small  a  part  of  the 
population  pays  such  a  large  proportion  of  the  yield. 
But  every  other  tax  is  subject  to  this  criticism,  in 
greater  or  less  degree.  The  general  property  tax 
reaches  only  the  comparatively  small  part  of  the  pop- 
ulation owning  property.  Privilege  and  occupation 
taxes  apply  only  to  those  exercising  the  privilege  or 
following  the  particular  occupation  subject  to  the 
law.  The  inheritance  tax  is  confined  to  those  who 
die  leaving  a  substantial  amount  of  property,  and 
even  the  poll  tax  is  limited  to  male  adults  of  certain 
ages.  The  test  of  a  tax  is  not  whether  it  reaches  the 
entire  population  but  whether  it  applies  equally  to 
all  persons  similarly  situated.  The  income  tax  satis- 
fies this  requirement  by  applying  the  same  rate  and 
imposing  the  same  burden  upon  all  persons  who  have 
the  same  income.  The  fact  that  those  who  have  large 
incomes  pay  a  larger  tax  is  readily  justified  by  their 
greater  ability  to  pay  and  the  greater  sacrifice  in- 
volved in  the  payment  of  a  tax  by  those  who  have 
small  incomes.  Moreover,  in  the  face  of  increasing 
public  expenditure  and  growing  demand  for  public 
revenue,  it  is  not  apparent  why  those  engaged  in 
business  yielding  liberal  returns  should  not  make 
corresponding  contributions  to  the  support  of  gov- 
ernment. The  income  tax  is  the  only  one  that  reaches 
all  classes  of  excess  earnings. 

Objection  is  often  made  that  an  income  tax  law  is 
inquisitorial,  but  so  are  all  tax  laws  when  properly 


INCOME  TAXES  47 

administered.  Under  the  propert}^  tax  law  the  asses- 
sor may  examine  the  taxpayer  and  call  his  neighbors 
to  testify  as  to  the  amount  and  value  of  his  property; 
He  may  even  disregard  the  taxpayer's  sworn  state- 
ment and  increase  the  assessment  as  justice  may  re- 
quire. According  to  a  recent  bulletin  of  the  Federal 
Census  Bureau,  the  cost  of  government  throughout 
the  United  States  has  practically  doubled  within  the 
last  ten  years,  and  there  is  little  to  indicate  that  the 
maximum  has  yet  been  reached.  In  the  face  of  these 
mounting  public  burdens,  taxes  will  be  imposed  in 
one  form  or  another,  and  the  public  will  insist  upon 
the  necessary  information  to  measure  the  amount 
chargeable  to  each  citizen.  Concealment  and  evasion 
will  not  permanently  avail.  The  choice  lies  be- 
tween a  flexible  and  adjustable  system  and  a  rigid 
and  mechanical  one,  with  a  long  train  of  injustice  in 
its  wake. 

CONCLUSION 

The  most  ardent  advocate  of  the  income  tax  will 
not  claim  that  it  is  free  from  imperfections  or  that 
it  offers  the  final  solution  of  all  tax  problems,  but 
experience  has  shown  that  both  in  theory  and  in  prac- 
tice it  more  nearly  satisfies  the  accepted  canons  of 
taxation  than  any  other  tax.  Our  review  of  the  sub- 
ject leads  to  the  conclusion 

(1)  That  the  income  tax  marks  the  latest  step  in 
the  evolution  of  the  effort  to  secure  contribution  to 
the  support  of  government  in  proportion  to  ability 
to  pay; 


48  MODERN  AMERICAN  LAW  LECTURE 

(2)  That  in  one  form  or  another  it  has  been  incor- 
porated  into   the   fiscal   system   of   every   civilized 
country  in  the  world ; 

(3)  And  that  in  practical  operation  it  has  proved 
an  efficient  method  of  raising  public  revenue  at  a 
minimum  of  hardship  to  taxpayers ; 

(4)  That  it  reaches  new  sources  of  revenue,  takes 
note  of  the  productiveness  of  different  classes  of 
property,   automatically  adapts  itself  to  changing 
conditions  and  graduates  the  burden  accordingly ;  and 

(5)  That  as  a  supplement  to  other  forms  of  taxa- 
tion it  can  be  utilized  to  advantage  on  either  a  local 
or  national  scale. 


GAYLAMOUNT®" 

PAMPHLET  BINDER 

=       Syracuse,  N.Y.  , 
SSS      Stockton,  Calif. 


Jf"  000  680  897     6 


